Articulation Is Not Action

November 5, 2009

Financial Literacy is as much a buzzword today as Good Governance used to be in the late 1990s and again in 2001 when corporate scandals and vanishing companies had disillusioned investors and the primary market lay dormant for a long period. Unfortunately, the rhetoric about financial literacy is not backed by any understanding or effort to address the issues that affect investors or customers of financial services.

For instance, advances in technology have not made it any easier for the ordinary person to open a bank account or obtain a legitimate phone connection because of the mindless application of KYC (Know Your Customer) rules; the lopsided implementation of the on-line tax regime and its draconian rules discourage people from paying taxes; mistakes in reporting tax deducted at source (TDS) are a nightmare and everybody has a personal horror story of struggling to resolve problems relating to credit cards, post-office savings or the activation/de-activation of telecom services. Moneylife routinely highlights these issues, but there is little action to find sensible systemic solutions to ensure acceptable service quality.

N Vaghul, former chairman of ICICI Bank, used to joke that Indians often tend to mistake articulation for action. The endless talk about financial literacy by our regulators is a classic example of this syndrome. You cannot address literacy without clarity about the extent of ignorance.

We took the first step to understanding this enormous issue through the Big Ideas Essay Contest conducted with Reliance Mutual Fund on the subject of Taking Financial Markets to the Masses. Participation was open to a tiny, informed segment—the students of management schools in the Mumbai-Pune region, which has the highest concentration of investors in India. We received nearly 100 responses and the winners will be chosen by an eminent jury from a shortlist of 17. But this article is more about the views of those who did not make it to the shortlist.

We found that the level of knowledge is limited to textbook definitions about markets; many confused financial inclusion with financial literacy and, although a number of submissions outlined barriers to the spread of investment culture, few had solutions to offer. An important detail was the number of students who suggested that using the 2.7 million strong army of insurance agents was probably the best way to reach out to people and interest them in the financial markets.

Interestingly, if the pension regulator has its way, the elimination of incentives to insurance agents is likely to kill this market in the next couple of years. Strange as it seems, our regulators believe that cutting commissions and dis-incentivising intermediaries/agents/distributors, by slashing commissions will expand markets by forcing people to become financially literate. The results could be exactly the opposite.

Clearly, commissions must be reasonable and investors should have the flexibility to switch agents who do not deliver the promised service. But is elimination of commissions the solution? Or is it a recipe for keeping retail investors out of financial markets? There is growing evidence that thoughtless regulatory diktats will damage the sector instead of growing it.

Consider this. SEBI decided to do away with mutual fund entry-loads and is yet to acknowledge that the move has hurt, rather than helped, retail investors, since it offers no alternative to fees earned by financial advisors. The New Pension Scheme (NPS), which is an excellent investment opportunity for young Indians (featured as Cover Story, Moneylife, 18 June), was opened to all citizens on 1 May 2009. But the response has been pathetic: just 2,321 subscribers (non-government employees) across the country until 21 October 2009. Why? Because the NPS operates on a no-load, zero commission basis, offering Rs40 for account opening and Rs20 per transaction to Points of Presence (PoPs) which are mainly banks.

Instead of examining what has gone wrong with the Scheme, the Pension Fund Regulatory and Development Authority (PFRDA), headed by a former IAS officer, plans to open the Scheme to private entities, giving it access to bulk subscribers and is strongly recommending the slashing of insurance commissions as well.

A consultation paper on “minimum common standards for financial advisors and financial education,” which is posted on the PFRDA website for feedback, talks about an “army of nearly three million financial advisors plus banking staff” (of these, 2.7 million are insurance agents and 55,000 are mutual fund agents) selling financial products and serving 188 million people holding financial assets.

Of these, it says, eight million participate in debt and equity markets, mutual funds or insurance-linked market products. This is the first official admission that India’s investor population is not the 20 million claimed for over a decade, but less than half that number at just eight million! Are the regulators worried? After all, doesn’t every regulator have a market development role that is on par with investor protection?

PFRDA, like others, is not short on articulation. It says, another 200 million investors are “waiting at the gate wanting to see some signs of traffic signals to feel safe enough to navigate the roads.” Well, the PFRDA has not noticed that eliminating agents’ incentives is like a red-signal that can halt retail investment.

According to the report, high front-loading of commissions (as much as 40% in the first year) to agents leads to mis-selling; otherwise the “average sum assured of the insured Indian would be higher than the current Rs90,000.” It also lauds SEBI’s decision to scrap mutual fund loads from August 2009. The PFRDA then pats itself on the back for choosing an ‘ethically mature path’ and ‘risking a slow start’ rather than offer commissions to attract investment. We would have applauded too, if it offered an effective alternative or a workable financial literacy programme based on a clear understanding of the target market. Instead, its absurd suggestion is to set up the Financial Well-Being Board of India (FINWEB) to regulate retail financial advisors cutting across regulators, products and markets to be combined with a national education effort. When will regulators understand that it is not about mindless regulation and registration but being able to tap the right influencers and ensure they have the ‘incentive’ to offer the right advice?

Until recently, the finance ministry and its favourite economists and editors used to parrot the line that retail investors invest only through mutual funds. Eighteen years after the entry of private mutual funds, some of these ‘experts’ are now willing to concede that choosing a mutual fund scheme from among the few hundred that are on offer is probably more difficult that picking a stock; the results can be even more uncertain. Funnily, most people PFRDA has consulted for the report, including mutual fund distributors, hardly deal with retail investors; nor do they think it is worth their effort. PFRDA wants insurance agents’ commissions to be cut to 15% immediately, slashed further to 7% by 2010 and turn nil by 2011, but offers no alternative model to reward agents for their services. This will only kill the insurance business. Along with it will perish the chance of increasing financial literacy and expand the market for financial products to allow a larger swathe of Indians to benefit from higher returns that accrue from sensible investing.